Section 6: Public Choice Theory

In this unit, we have learned about fiscal policy and the expenditures and revenues of the various forms of government in the United States. The economic theory that studies the effectiveness of government (public) spending and taxation and the behavior of politicians and legislators is called public choice.

Public choice became popular after James Buchanan (pictured) and Gordon Tullock from George Mason University published their The Calculus of Consent in 1962 and it received widespread public attention after James Buchanan won a Nobel Prize in 1986 for his public choice research.

Government Failures

Due to the influence of John Maynard Keynes, the focus had been on “market failures” and what the government could do to fix these. Public choice theorists pointed out that there are also “government failures.” Politicians are no different from private sector participants in that they are motivated by their self-interest. Politicians’ self-interest includes wanting to get re-elected during the upcoming elections and a need for power and recognition. When voters are satisfied, politicians generally will get re-elected. Voters are satisfied when their favorite programs are funded and when tax rates are relatively low. But many voters are not aware of specific funding and programs and laws, especially if they don’t affect them. Some voters simply don’t care about many laws and whom they vote for, because they believe that their one vote will not decide the election outcome.

Special Interest Groups

Special interest groups are groups that have a lot to gain or to lose if a certain law gets passed or doesn’t get passed. For example, auto workers, trade unions, students, teachers, and senior citizens are special interest groups. These groups have an incentive to know and to vote for a certain law or government program, because it directly affects their incomes and their lives. For this reason, politicians cater to special interest groups, even if the action hurts the economy in general. For example, let’s assume that a law (for example, the raising of tariffs and quotas) benefits 50,000 special interest group members (for example, workers in the auto industry). Let’s say that if this law is passed, each member gains $2,000. Then the total benefit to society is $100 million. Let’s also say that this law hurts consumers and exporters of U.S. products (because of protectionist retaliation by other countries), and the cost is $100 per person. Multiplied by 2 million affected citizens, the total cost to society is $200 million. Therefore, the total cost of $200 million outweighs the total benefit of $100 million. From a macroeconomic point of view, the law should not get passed. However, politicians will likely support the law, because the general population is probably not aware of the law, whereas the special interest group is, and its members promise the politicians votes and financial incentives if the law gets passed.

The flat tax system, as discussed in one of the previous sections in this unit, is probably beneficial to the economy because of its simplicity and the cost savings to the public due the decreased need for accountants and government tax workers. However, the flat tax system will not likely ever be passed, because the current progressive and complicated system is full of exceptions, exemptions, and deductions favoring special interest groups. As mentioned, politicians benefit from catering to these special interest groups, and eliminating this characteristic from the tax system is not in the politician’s best interest.

Politicians Favor the Short Run

A politician’s term is usually four years, and elections for various positions are held every two years. This is a relatively short period of time. Subsequently, politicians, in their focus to get re-elected, will do what is best for the economy in the short run and not necessarily for the long run. A politician, who has a choice of building a road that lasts 25 years, but costs a lot (raise taxes now), or building a road that lasts 8 years (no need to raise taxes), will likely choose the latter. However, society will pay more, in the long run. Most politicians have little incentive to cut long-run costs because it is not their own money they are spending. They are spending other people’s money.

Politicians Form Alliances

Politicians often work together with other politicians to pass projects that may not benefit the economy as a whole. A politician from Florida may support a costly catastrophe insurance bill and will ask politicians from the Midwest to support her/his measure, with the understanding that (s)he will support their bills to subsidize farmers from the Midwest. This “log rolling” or “vote trading” is common and leads to so called pork-barrel spending. This contributes to harmful and inflationary government spending and taxation.

The Capture Theory

The “capture theory” states that regulators are “captured” by certain laws and by the people affected by the laws. In order to become a regulator, the regulator has to be knowledgeable about the industry that (s)he regulates. The regulator, therefore, has most likely worked in the industry and still has a network of friends and acquaintances in the industry. Furthermore, the regulatory agency is often funded by sources from the industry or by Congress, which is influenced by these industries. Such interrelationships and conflicts of interest often lead to regulations and laws that are not in the best interest of the country.

The Nature of Non-Profit Offices

Government (and other non-profit) offices submit a budget each fiscal year. The amount of money allocated in each office’s budget is often determined by the amount of funds spent in the previous year. Subsequently, if toward the end of a fiscal year not all the funds are expended, the members of the division will spend the funds, regardless of whether the money is spent wisely or not. This causes a tremendous waste in resources and a level of taxation that is much higher than necessary.

Video Explanation
For a video explanation of a sample multiple-choice question about Public Choice, please visit:

Attempts to Correct Government Failures

Some economists have attempted to correct these “government failures.” These attempts have focused on incorporating more competition between government divisions. For example, transferring some government services to local governments may help, because voters are more aware of what their county governments do and what taxes they levy. This allows voters to vote with “their feet.” If they are not happy with the government services and taxes in their county, they will move to the next county if that county is more efficient and more effective. Rodney Fort and John Baden have suggested the creation of a “predatory bureau,” which is rewarded by reducing the budgets of other agencies. Other economists have encouraged charging individual citizens for otherwise free government services. If people are charged for their services, they will be more motivated to critically evaluate the effectiveness and efficiency of the service.

Some economists have suggested to limit politicians to one term. This way they will be less likely to make decisions that favor the short run, frequently at the expense of long run economic health. In the current system elections are usually just around the corner and sitting politicians want the economy to look good so that they can increase their chances of getting re-elected. When politicians have a one term limit, they know that they will return to the “real world” after their term. This encourages them to make decisions that are better for the long run and best for the country as opposed to what is good for themselves (i.e. to get re-elected).